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Research Coverage
September 2023
Important Information:
This webinar contains information specifically intended for institutional clients, asset consultants, advisers, platforms and researchers, who are professional investors and wholesale clients (as defined in the Corporations Act 2001).
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Key takeaways
In a world where global equities seem to shrug off all manner of macro-economic shocks, it’s easy to overlook the strengths of other sub-segments of the asset class and the growing risks within portfolios weighted toward the biggest companies in the world.
In this article, we discuss the merits of Global SMID Cap Equities and their role in enhancing portfolios over the long-term and why the current period presents a favourable opportunity to gain exposure to these investments.
But first, what are Global SMID Cap Equities?
From an index-perspective, Global SMID Cap Equities are defined by MSCI as being the smallest 28% of companies by market capitalisation across the 23 developed market countries’ indices. Names you may recognise include Yeti, Thule, The Home Depot, and Moncler.
While the index-based data within this article relates to the MSCI SMID Cap Index for comparison purposes, in our view, the methodology used in this index’s construction is somewhat illogical. It overlooks the fact that the smallest 28% of each market will vary greatly by market cap, meaning the index is less liquid than it should be, and includes some large outlier companies, while omitting others within expected market cap ranges.
Within our strategy, we overcome this issue by applying the 28% threshold rule to the entire MSCI World Index rather than to each market. We feel this helps us to compare ‘apples with apples’ and provides us with a more diverse and liquid investable universe.
Diversification with reduced concentration risk
We believe the concentration risk associated with the dominance of a handful of companies is clearly a diversification issue for investors, particularly given the heavy skew toward one country (US) and one sector (Technology).
As at 19 June 2023, just six companies in the MSCI World Index were responsible for delivering 75% of the returns so far this calendar year.
Compounding this issue is the fact that increased passive exposure from investors has resulted in increasing large cap exposure, while active managers have collectively maintained material exposure to the large cap names as they have grown. We believe this issue can also be self-perpetuating as passive funds continue to re-weight to match the makeup of the index they mimic.
We feel that one of the most obvious benefits of an allocation to Global SMID Cap Equities is that it can help to reduce this stock concentration risk within portfolios, while providing a source of equity market returns diversified across more than 5,000 companies, three regions, 23 countries and 11 sectors.
Chart 1: MSCI World SMID Cap Index
An investment universe diversified by sector and region
Sector weights (outer ring), region weights (inner ring)
A growth investment with attractive risk-adjusted returns
Global SMID Cap Equities play a growth role within investors’ portfolios, providing exposure to businesses that are in the ‘sweet spot’ of their long-term earnings growth journey.
Compared to other equities sub-segments, Global SMID Cap Equities offer relatively attractive returns for the level of risk taken. As shown below in Chart 2, since 1999, Global SMID Caps Equities’ average returns have been in line with those of Emerging Market Equities1. However, with a standard deviation 18% lower than Emerging Market Equities, the return series for Global SMID Cap Equities has been far less volatile or unpredictable for investors.
Meanwhile, comparing Global SMID Cap Equities2 to Global Equities3, on average, Global SMID caps have provided an incremental annual return of 1.82% over the past 24 years.
Chart 2: Equities Index Average Annual Returns and Standard Deviation since 1999
Global SMID-cap Equities – excess returns for modestly higher risk
Valuations are well below their long-term norm
In our view, there is currently a window of opportunity within Global SMID Cap Equities for investors to take advantage of a market dislocation that looks to have temporarily bucked long-term valuation trends.
Compared to the average experienced over the past 10 years, Global SMID Cap Equities have been trading at a 40% discount to the MSCI World Large Cap Growth Index, with a price to earnings ratio (P/E) of 15.5x earnings. For investors, this means they currently have the opportunity to gain exposure to a large pool of companies, which includes many high-quality names at a relative discount.
Chart 3: Comparative P/E (forward) SMID versus Large Cap Growth
Global SMID Cap Equities currently trade at a 40% discount to Large Cap Growth
Chart 4: Ratio P/E SMID versus World
Relative to global equities, SMID Caps now heavily discounted from their 10-year average
Unlocking growth potential
While sometimes painted as the poor cousin of large and mega cap equities, Global SMID Cap Equities are arguably better equipped to cater to investors seeking a broadly diversified source of growth in their portfolio. Global SMID Cap Equities’ alpha is diversified by sectors and regions, as opposed to broader global equities which exhibits a heavy skew to US technology stocks.
While the long-term return series shows incremental performance and lower volatility compared to broader equities, in our view it is the current valuations of Global SMID Cap Equities that are exciting us most about the short-to-medium-term investment opportunities.
Investors aiming to achieve improved risk-adjusted returns and mitigate valuation risk could potentially benefit from allocating a portion of their Global Equities portfolio to high-quality Global SMID Cap companies.
IMPORTANT INFORMATION
1 Emerging Market Equities = MSCI Index: MSCI EM-ND in USD.
2 Global SMID Cap Equities = MSCI Index: MSCI World SMID Cap-ND
3 Global Equities = MSCI Index: MSCI ACWI-ND in USD.
All index data is in USD unless otherwise specified.
IMPORTANT INFORMATION
This article was prepared for Bell Asset Management Limited (BAM) ABN 84 092 278 647, AFSL. Distribution by Channel Capital Pty Ltd ACN 162 591 568 AR No. 001274413 (Channel). Neither BAM nor Channel warrant the accuracy, reliability or completeness of the information. This article has been prepared by BAM for information purposes only and does not take into consideration the investment objectives, financial circumstances or needs of any particular recipient – it contains general information only. No representation or warranty, express or implied, is made as to the accuracy, completeness or reasonableness of any assumption contained in this report. Past performance is not necessarily indicative of expected future performance.
Key takeaways
In a world where global equities seem to shrug off all manner of macro-economic shocks, it’s easy to overlook the strengths of other sub-segments of the asset class and the growing risks within portfolios weighted toward the biggest companies in the world.
In this article, we discuss the merits of Global SMID Cap Equities and their role in enhancing portfolios over the long-term and why the current period presents a favourable opportunity to gain exposure to these investments.
But first, what are Global SMID Cap Equities?
From an index-perspective, Global SMID Cap Equities are defined by MSCI as being the smallest 28% of companies by market capitalisation across the 23 developed market countries’ indices. Names you may recognise include Yeti, Thule, The Home Depot, and Moncler.
While the index-based data within this article relates to the MSCI SMID Cap Index for comparison purposes, in our view, the methodology used in this index’s construction is somewhat illogical. It overlooks the fact that the smallest 28% of each market will vary greatly by market cap, meaning the index is less liquid than it should be, and includes some large outlier companies, while omitting others within expected market cap ranges.
Within our strategy, we overcome this issue by applying the 28% threshold rule to the entire MSCI World Index rather than to each market. We feel this helps us to compare ‘apples with apples’ and provides us with a more diverse and liquid investable universe.
Diversification with reduced concentration risk
We believe the concentration risk associated with the dominance of a handful of companies is clearly a diversification issue for investors, particularly given the heavy skew toward one country (US) and one sector (Technology).
As at 19 June 2023, just six companies in the MSCI World Index were responsible for delivering 75% of the returns so far this calendar year.
Compounding this issue is the fact that increased passive exposure from investors has resulted in increasing large cap exposure, while active managers have collectively maintained material exposure to the large cap names as they have grown. We believe this issue can also be self-perpetuating as passive funds continue to re-weight to match the makeup of the index they mimic.
We feel that one of the most obvious benefits of an allocation to Global SMID Cap Equities is that it can help to reduce this stock concentration risk within portfolios, while providing a source of equity market returns diversified across more than 5,000 companies, three regions, 23 countries and 11 sectors.
Chart 1: MSCI World SMID Cap Index
An investment universe diversified by sector and region
Sector weights (outer ring), region weights (inner ring)
A growth investment with attractive risk-adjusted returns
Global SMID Cap Equities play a growth role within investors’ portfolios, providing exposure to businesses that are in the ‘sweet spot’ of their long-term earnings growth journey.
Compared to other equities sub-segments, Global SMID Cap Equities offer relatively attractive returns for the level of risk taken. As shown below in Chart 2, since 1999, Global SMID Caps Equities’ average returns have been in line with those of Emerging Market Equities1. However, with a standard deviation 18% lower than Emerging Market Equities, the return series for Global SMID Cap Equities has been far less volatile or unpredictable for investors.
Meanwhile, comparing Global SMID Cap Equities2 to Global Equities3, on average, Global SMID caps have provided an incremental annual return of 1.82% over the past 24 years.
Chart 2: Equities Index Average Annual Returns and Standard Deviation since 1999
Global SMID-cap Equities – excess returns for modestly higher risk
Valuations are well below their long-term norm
In our view, there is currently a window of opportunity within Global SMID Cap Equities for investors to take advantage of a market dislocation that looks to have temporarily bucked long-term valuation trends.
Compared to the average experienced over the past 10 years, Global SMID Cap Equities have been trading at a 40% discount to the MSCI World Large Cap Growth Index, with a price to earnings ratio (P/E) of 15.5x earnings. For investors, this means they currently have the opportunity to gain exposure to a large pool of companies, which includes many high-quality names at a relative discount.
Chart 3: Comparative P/E (forward) SMID versus Large Cap Growth
Global SMID Cap Equities currently trade at a 40% discount to Large Cap Growth
Chart 4: Ratio P/E SMID versus World
Relative to global equities, SMID Caps now heavily discounted from their 10-year average
Unlocking growth potential
While sometimes painted as the poor cousin of large and mega cap equities, Global SMID Cap Equities are arguably better equipped to cater to investors seeking a broadly diversified source of growth in their portfolio. Global SMID Cap Equities’ alpha is diversified by sectors and regions, as opposed to broader global equities which exhibits a heavy skew to US technology stocks.
While the long-term return series shows incremental performance and lower volatility compared to broader equities, in our view it is the current valuations of Global SMID Cap Equities that are exciting us most about the short-to-medium-term investment opportunities.
Investors aiming to achieve improved risk-adjusted returns and mitigate valuation risk could potentially benefit from allocating a portion of their Global Equities portfolio to high-quality Global SMID Cap companies.
IMPORTANT INFORMATION
1 Emerging Market Equities = MSCI Index: MSCI EM-ND in USD.
2 Global SMID Cap Equities = MSCI Index: MSCI World SMID Cap-ND
3 Global Equities = MSCI Index: MSCI ACWI-ND in USD.
All index data is in USD unless otherwise specified.
IMPORTANT INFORMATION
This article was prepared for Bell Asset Management Limited (BAM) ABN 84 092 278 647, AFSL. Distribution by Channel Capital Pty Ltd ACN 162 591 568 AR No. 001274413 (Channel). Neither BAM nor Channel warrant the accuracy, reliability or completeness of the information. This article has been prepared by BAM for information purposes only and does not take into consideration the investment objectives, financial circumstances or needs of any particular recipient – it contains general information only. No representation or warranty, express or implied, is made as to the accuracy, completeness or reasonableness of any assumption contained in this report. Past performance is not necessarily indicative of expected future performance.
